Fuel Hedging: Theory vs. Practice

Fuel is one of the single largest operational costs for airlines. Its unpredictable & extreme volatility can pose a serious issue, exposing operators to sudden cost increases. To address this, airlines use hedging instruments to lock in a specific price or price range for future fuel purchases.

Operationally, hedging provides cost predictability, enabling better long-term planning of seat capacity and pricing. Cost predictability also translates into more predictable and stable profitability for airlines.

For decades, Singapore Airlines (SQ) has had a fuel hedging program “𝘪𝘯𝘵𝘦𝘯𝘥𝘦𝘥 𝘵𝘰 𝘮𝘢𝘯𝘢𝘨𝘦 𝘵𝘩𝘦 𝘷𝘰𝘭𝘢𝘵𝘪𝘭𝘪𝘵𝘺 𝘪𝘯 𝘰𝘪𝘭 𝘱𝘳𝘪𝘤𝘦𝘴 𝘢𝘯𝘥 𝘵𝘩𝘦 𝘳𝘦𝘴𝘶𝘭𝘵𝘢𝘯𝘵 𝘪𝘮𝘱𝘢𝘤𝘵 𝘰𝘯 𝘪𝘵𝘴 𝘯𝘦𝘵 𝘧𝘶𝘦𝘭 𝘦𝘹𝘱𝘦𝘯𝘥𝘪𝘵𝘶𝘳𝘦. 𝘛𝘩𝘦 𝘬𝘦𝘺 𝘰𝘣𝘫𝘦𝘤𝘵𝘪𝘷𝘦 𝘧𝘳𝘰𝘮 𝘵𝘩𝘪𝘴 𝘱𝘳𝘰𝘨𝘳𝘢𝘮𝘮𝘦 𝘪𝘴 (...) 𝘢 𝘭𝘰𝘸𝘦𝘳 𝘷𝘢𝘳𝘪𝘢𝘯𝘤𝘦 𝘪𝘯 𝘧𝘶𝘦𝘭 𝘤𝘰𝘴𝘵𝘴 𝘳𝘢𝘵𝘩𝘦𝘳 𝘵𝘩𝘢𝘯 𝘩𝘦𝘥𝘨𝘪𝘯𝘨 𝘨𝘢𝘪𝘯𝘴.” Most airlines around the world have similar motives.

A robust & consistently executed fuel hedging program fully geared to address volatility, should – in theory – lead to a net gain/loss of zero over a prolonged timeframe. The hedging instruments deployed (options, futures, swaps or forwards) are of secondary importance and only a means to achieving the underlying objective: managing volatility.

True to their word, the graph highlights that SQ’s hedging performance has indeed addressed volatility:

- If Jet A1 prices rose, hedging gains were booked.
- If Jet A1 prices fell, hedging losses were booked.

Unfortunately, the airline still booked a net hedging loss of -S$885m over 20 years. Two reasons explain why the airline has not achieved a hedging outcome closer to zero:

- Inconsistent Hedging Strategies: SQ adjusted its strategy multiple times in this 20 year timespan. For example, it initiated an opportunistic longer-term hedging program in 2016, which was discontinued during COVID.
- Loose Framework & Guardrails: In 2014, the airline hedged between 20 - 60% of its fuel requirements. In other words, management had a 40% leeway to speculate. Adjustments have since taken place.

A consistent and unchanged framework, in which a pre-defined % of fuel was hedged over a pre-defined period, without flexibility or leeway for adjustments, would’ve generated a net gain/loss of zero (or thereabouts).